Was there an arm’s length relationship between Ruparelia and the members of management of his bank?
By Sam Senkaayi Nyanzi
"I have found a flaw in the model that I perceive is the critical functioning structure that defines how the world works," said Alan Greenspan, the former Chairman of the Central Bank of the US, while admitting that he had been naive to believe in the self-correcting power of free markets; an ideology that prevented him from foreseeing the self-destruction that bankers are capable of inflicting on their own institutions.
Greenspan's reluctant attempt at mea culpa for his role in the global financial crisis was extracted from him in pointed questioning from Lawmakers during a Congressional hearing on the economic crisis in 2008. Flash forward to October 20, 2016, the day on which the Bank of Uganda assumed statutory management of Crane Bank Limited because of capital depletion, risks to financial system stability, and potential jeopardy of deposits.
Events since that famous October day have seen Crane Bank undergo an inevitably terminal resolution process that is now at a contested stage before the Commercial Court. Prior to this moment of ignominy, Crane Bank was much celebrated for industry-beating performance. The public face and prime promoter of this bank, Sudhir Ruparelia, gained lionised status as a mogul worthy of inclusion in the Forbes Rich List. Moreover, Crane Bank was regulated by the Bank of Uganda, which had modernised its toolkit following the domestic banking crisis of the late 1990s by adopting risk-based supervision guided by the Basle Core Principles of Banking Supervision. So, where was the critical flaw in this picture?
How does a well-regulated and exceptionally profitable bank that is championed by a successful business tycoon suddenly fall like a house of cards? Whichever way you look at this saga, the core of the problem is the huge losses that the bank incurred due to non-performing loans that completely ate away its financial health. The losses were so huge that the bank's liabilities grossly exceeded its assets; and it became insolvent. As such, it was no longer complying with the prudential requirements of a financial institution operating in a safe and sound manner, when the regulator came knocking at the door.
It has been alleged that the rapid deterioration to fatal losses was visited on Crane Bank because its prime promoter, Ruparelia, unduly influenced the extension of large loans to prominent business people; some of whom are members of hiskwagalana fellowship of tycoons. On his part, Ruparelia rationalised that it is the poor performance of the economy that was the culprit. Inadvertently, he betrays the possibility that the bank's loan performance would go whichever way the economy tended to fluctuate; moving from boom to bust. In either case, there exists an institutional mechanism, at least on paper, by which prudent lending should take place.
And so it is necessary to establish if the institutional mechanism, including following internal credit policies, prudential lending limits on exposures, rigorous risk management, as well as management and board oversight, among others, were followed.
For the benefit of readers, a bank is supervised in a four-pronged way, as follows:
(1) By a Board of Directors, which mainly fulfils this role through an audit committee, among others.
(2) The bank's internal auditor, who must smell any malfeasance; raise the flag and promptly notify the Board.
(3) The bank's external auditors, who must also sniff and pinpoint any wrongdoing. (4) Finally, the Central Bank i.e. BoU. It largely premises its regulatory role on the commercial bank's performance relative to a set of regulatory requirements. In principal, it may also rely on the honesty and integrity of the aforementioned three groups.
All the above notwithstanding, was there an arm's length relationship between Ruparelia and the members of management of his bank? Or did he dominate both the management and Board of Directors? The pendulum appears to swing in the direction of complete dominance of the bank and Board by the key promoter; who it is alleged was also the sole owner of the bank, contrary to the law.
This assertion may not be arrived at casually because as you might recall from the central bank's announcement of the statutory management of Crane Bank that the Board of Directors had been suspended; in addition to firing of the bank's managers. This is not a small matter for a member of such a board, because once dismissed from a collapsed bank, they are unlikely to ever be approved for membership on the board of any other supervised financial institution, or granted a licence to run a supervised financial institution should they seek one in the future.
They are unlikely to pass a "fit and proper" check by the central bank ever again. Why would members of the Board let loose a dominant shareholder to compromise all corporate governance standards in the running of the bank? Perhaps, the answer lies in understanding the concept of "group think", where the members aligned themselves with the judgement of the successful and powerful business mogul, who had looked on them favourably by choosing them to be on his Board.
Why the gamble?
This brings us to the more critical question facing Ruparelia. How could he take the risk of gambling with his bank's fortunes? Once lost, a banking licence cannot be regained. It has been argued that one of the advantages that family businesses possess is that they are built for the long haul and run on an inter-generational basis. It is in the selfish interest of the current generation to pass the reins of leadership to the next generation. And indeed, Crane Bank betrayed signs of being a family business. Members of the Ruparelia household were owners, members of the Board, and held executive management roles both on paper and/or in practice. Why would the same family engage in self-sabotage on such a grand scale through lending practices that were inconsistent with prudent finance? Why pervert a good thing that was bringing in the daily bread?
An ancient Greek saying states that "Whom the gods would destroy, they first make mad". This brings to mind Mihir Desai's book titled The Wisdom of Finance in which he argues that finance, unlike most professions, gives its practitioners rapid feedback on their performance; and if they do well, they become arrogant and greedy. Having been blessed with deal-making acumen and the smarts of entrepreneurship to start businesses across sectors, Ruparelia won accolades and celebrity. At the crest of its boom times, Crane Bank won multiple international accolades as Bank of the Year.
Through Crane Bank, Ruparelia is alleged to have extended huge loans to all manner of borrowers who had the sort of security he wished to possess at unsustainably high interest rates that he inevitably took possession of the property titles. As such, he is said to be the most dominant landlord in Kampala. Anecdotal stories abound of prominent businessmen and property owners who survived his web of acquisition via usurious loans only by a whisker. Indeed, he spread his reach into the education sector by way of a very expensive loan to a prominent educationist. He probably could not help himself from extending one more loan; taking one riskier bet for the promise of one more property, leading to one extra billion for his next Forbes List assessment.
This brings us back to the regulator. Are there any flaws to be discovered? Regulators are often heard saying that every supervised financial institution is safe and sound on an on-going basis, until the moment it is no longer so. Some may say that previous performance is not a guarantee against existential crises. However, any objective outsider must ask themselves the question: why is it that it took a forensic audit following statutory management takeover of Crane Bank by the Central Bank to unearth the alleged rotten core of the bank and reveal massive fraud including asset stripping of the bank?
Why is it that the forensic auditors and bank examiners looked at the same commercial bank's books and affairs and came out with different results? Is the post 1990s regulatory framework that the central bank depends on to supervise banks, still fit for purpose? Is the rest of the financial sector well supervised? And why is it that it is the local banks that tend to fail; do Ugandans lack the banking gene?
To be fair to BoU, a routine bank examination is based on self-reported data supplemented by occasional direct inspection of banks in the branches. It appears that the central bank does bank supervision on a basis of trust but verify. This, perhaps, is akin to a routine audit by external auditors. On the other hand, a forensic audit seeks to verify without trusting the self-reported information from the subject. Being more intrusive, the forensic audit is likely to be a lot more expensive.
Therefore, it stands to reason for BoU to rely on the routine bank examination most of the time and deploy the forensic audit occasionally since it is likely that the majority of the banks are bound to be compliant with regulatory requirements. One would not wish to carry around a bazooka where less menacing weapons are suitable. But by only paying attention to checking the regulatory requirements boxes, the regulator takes the risk of being lulled into a benign mind frame by a compliant majority of banks leaving the system vulnerable to the proverbial non-compliant black swan.
BoU likely to be more intrusive?
On the surface, it appears that the BoU must resort to supervising banks by being more smartly intrusive. Banking is evolving from physical branches to electronic platforms. Regulators must revisit their regulatory framework and tools to ensure that they are fit for the times rather than lagging behind the curve. They also stand to gain a lot by building capacity of bank examination teams both in forensic and human skill sets so as to enhance the verification of self-reported information from banks on a continuous basis rather than performing post-mortems.
The supervision mechanism can also be boosted by regularly changing the bank examination teams just as external auditors of commercial banks must be changed periodically. It is not a far-fetched notion to have the East African Community establish a mechanism where the partner States central banks blend bank examination teams by sharing staff so as to get fresh sets of external eyes unfamiliar with the regulated institutions. This could be extended to key persons of supervision functions being contracted to serve on fixed terms of limited duration.
When all is said and done, the failure of Crane Bank can be traced to the massive losses and alleged asset stripping of the bank in an environment of weak corporate governance, characterised by group think, that is, dominance by Ruparelia over the management and Board. He is larger than life and probably overshot his runway. And while there remains room for improvement on the part of the regulator, the Bank of Uganda is handling the resolution of the failed bank without harming the interests of the banking public or unduly disrupting the financial sector. That is a commendable result that the erstwhile rock star of central banking, Greenspan, may not boast of. The Crane Bank saga was not inevitable. Does it have a clear villain? The verdict is yours dear reader.
Writer is an economist and educationist